Markets are funny creatures. Most of the time, they are rational and thoughtful, and the market narrative is consistent with what is actually going on.
Then there are days like last Friday and today.
The market narrative is relatively straight forward: Wages are firming, inflation is finally manifesting itself and, as a result, rates are going to rise. That, as you know, will be the end of the world as we know it. Thus the sell-off.
That sell-off narrative is also closely correlated with the rapid rise in rates. So, it must be true.
What Seems True May Not Be
But if you look a little deeper, what seems true on the surface may not be entirely true. The list of anomalies is quite large, in my opinion. Relatively speaking, currently:
- Utilities are doing quite well. Why would that be the case, if rates were the driver of the markets?
- Value is NOT doing very well. Why would that be the case, if rates were the only driver of the markets?
- Investment-grade credit spreads are holding steady, while high-yield spreads are getting hit hard. Typically, that is not the case in a rising rate-driven market.
I think what we had this past Friday is a relatively endogenous market event: An old-fashioned market risk-off related sell-off.
While the net result is the same, it is important to analyze the cause to see how the markets will react in the aftermath of Friday’s sell-off.
Given the likelihood of global economies doing quite well in the first half of 2018, the likelihood that global rates remain in a sell-off for some time can’t be ruled out. If higher rates are the primary driver, a lot of caution on the part of investors is warranted in the near to even medium term.
On the other hand, if it is a simple risk-off event and not primarily driven by rates going higher from a cyclical standpoint, the outlook for the markets is relatively sanguine.
While the next few days will likely prove the thesis one way or the other, I am voting for the second proposition: It’s a typical risk-off event, and this too shall pass.